MARKET PRICING 101: ESTABLISHING A BENCHMARK METHODOLOGY UNIQUE TO YOUR ORGANIZATION
For compensation professionals, market pricing sits at the core of many responsibilities and outcomes. Establishing and managing salary structures, designing short-term incentive plans, conducting equity analysis, distributing merit increases during the performance management process – all of these things rely on, to some extent, accurate market pricing. Since it’s so important and affects so many other processes, your market pricing activities must be thoughtful, organized, repeatable, accurate and above all, aligned with and reflective of the various labor markets in which your organization competes for talent. What is the best way to ensure this happens? Start by developing a benchmark methodology.
What is a Benchmark Methodology1?
A benchmark or market pricing methodology is a framework for organizing the steps you will take to accurately, consistently and efficiently conduct market pricing in your organization. Its purpose is to ensure that anyone that sets out to market price jobs will do so using agreed-to, consist methods of collecting, weighting and combining data. Additionally, part of establishing a benchmark methodology is to develop a thorough understanding of the relevant labor market which will then be translated into what surveys are selected and what data is incorporated.
The Elements of a Benchmark Methodology
Though the level of detail in a benchmark methodology may vary, at a minimum to ensure market pricing consistency, it should comprise of the following elements.
A compensation philosophy is your starting point. If you don’t have one – STOP! Do not attempt to create a benchmark methodology without an understanding of how your organization wishes to position pay amongst their labor market competitors. A compensation philosophy statement can be something as simple as “ABC, Inc. targets pay at the median.” Or, very often today, the statement will include details such as how base pay is positioned versus variable pay, a statement regarding the labor market competitors, and the role that pay-for-performance plays. Either way, you must understand what your company’s target pay positioning is in order to develop a benchmark methodology. If that’s not in place, that’s your first task – get to work!
With the huge budget you have at your disposal, it’s easy to purchase lots of surveys, right? If that is your situation, cheers to you! Most of us, however, have a limited budget and need to be strategic when selecting which surveys to purchase. Be sure to select reputable surveys that reflect your labor market competitors and will cover a significant amount of the various positions within your organization. For additional guidance on what to consider when selecting surveys, read Survey Participation: Tips for Success.
Scope Cuts and Data Elements
Part of developing a benchmark methodology is understanding how you recruit – and how that recruitment strategy may differ by employee segment. In most organizations there is a portion of the jobs where the talent typically comes from a variety of industries – meaning it’s not important that candidates have a background in your particular industry. For example, Human Resources jobs or Administrative Support roles can typically be filled by professionals who can demonstrate the skills you are looking for regardless of prior industry experience. They can learn the nuances of your industry. However, other roles require specific industry experience or even experience working in organizations of a particular revenue size or type of organization, such as a not-for-profit organization. The survey scope cuts that you choose to use should be aligned with the type of experience you require for each role.
Beyond the data scope cuts, you’ll also want to be sure to document the data elements that you will use from each survey. There’s nothing more frustrating than collecting data from a survey and beginning to load it into your market pricing tool, whether that’s a tool like MarketPay or just a spreadsheet, and realizing you’re missing data elements that you need. Using your compensation philosophy as a starting point identify the necessary data elements that you will need in order to analyze your pay competitiveness each year. Most organization will collect some variety of base pay, short-term incentive target, long-term incentives, total cash compensation, and total direct compensation at the 25th, 50th, and 75th percentiles. However, what each of these elements is called in each survey will vary and you may need additional elements as well. Use your benchmark methodology as a place to document what data elements will be pulled for each data cut in each survey. Then, when you are collecting data to update your market pricing you will have a clear checklist to follow that will improve efficiency, consistency and accuracy.
Best practice has always been to attempt to collect three survey data points for every job that you are market pricing. As you probably know, not only is that difficult to achieve, but with multiple data points for every job you are then faced with the challenge of how to combine those data points. Again, consistency and efficiency can be achieved by establishing a set of guidelines for blending data in your benchmark methodology.
All surveys have different effective dates. In order to use the survey data accurately, you need to apply an aging factor – a multiplier using some percentage of the coming year’s predicted pay increase percentage such as those found in Mercer’s US Compensation Planning Survey. What aging factor you use will depend on whether you wish to lead, lag, or lead/lag the market. If you wish to lead the market, you would age your data a full year ahead which means that as other companies are adjusting employees’ pay, you have already accounted for that adjustment in your market data. If you are more cost conscious and wish to lag the market, then you would only age the data to the start of your upcoming performance year. A lead/lad approach would mean you age data to the mid-point of your coming performance year.
You can apply different weights to the individual data elements to make them more or less important in the resulting data composite. For example, data from a particular survey may be discounted due to the perceived relevance of the participants to the role being market priced. Or, conversely, a premium may be applied to data in order to make it better reflect the additional roles and responsibilities of a job in your organization. Weights can be applied to data for a variety of reasons – and it can get confusing to try and keep the reasoning straight. Document the methods as well as how the weighting should be captured in your market pricing tool to make analysis, auditing and replication more efficient.
The simplest method for developing composites it to take an average of the adjusted market data2 for each pay element. Though, even in that case, you will need to determine how to address data anomalies such as zeros.
Alignment to Employee Segments
While you have already identified the scope cuts, you now need to determine and document how the data will be aligned to the various employee segments. Typically, it’s suitable to take broad employee groups or departments (e.g., Finance) and consider the experience desired, then translate that into the appropriate data scope. However, in some cases, it may be necessary to think in terms of jobs. A sample of a table outlining the data cuts that will be used for jobs in a healthcare organization is provided below.
Establishing a Benchmark Methodology
Assuming you have a compensation philosophy to start with, the next step is to ensure understanding of your various labor market competitors and talent strategy. To do so, you can engage either the human resources team members that represent the various employee segments within your organization or the department/business leaders themselves. Gather these resources together and begin by educating them on what it is you are developing – give them a little ‘Compensation 101’ that leads to how you will use a benchmark methodology and how critical their input is. By engaging these resources in the process not only are you developing a more accurate methodology, which leads to more accurate market pricing, but you are also developing some understanding amongst members of the organization that can be critical when it comes to explaining compensation decisions to the broader workforce.
After confirming the nuances of the competitive labor market for your various employee segments, it’s up to you to begin developing the benchmark methodology including the elements described above.
In some cases, developing a benchmark methodology for your organization may be a job that benefits from some third party advice or review. In that case, don’t hesitate to engage the likes of Mercer or one of the other reputable consulting firms. Developing a comprehensive benchmark methodology is an important step that will provide major advances in terms of efficiency, accuracy, and consistency. Trust us, the time spent is minimal compared to the gains.
For more information on developing a benchmark methodology or similar topics, look for other articles in our “Market Pricing 101” series.
1 The terms market pricing and benchmarking do have different meanings but are often times used interchangeably. For the purposes of this article, a “benchmark methodology” is used to guide any and all market pricing activities that take place in the organization, not just those of benchmark roles.
2 By “adjusted market data” we mean the data after any premiums/discount weighting are applied.